What has driven the European equities rally in 2017?
I think we have to modify our understanding of just how strong it has been. You have to modify it by the currency. If you had been a sterling investor in Europe, you have enjoyed it. Not just the last year, or 2017 to date; in fact the last five years have been fantastic for a sterling-based investor. Sterling has had a very meaningful devaluation that, as we speak, continues. If you had been a euro investor in Europe, returns year-to-date have been single digit.
What is really driving this? As ever there are a number of forces, but earnings is fundamental to this. The earnings trajectory has been good in certain sectors that were formerly not very good. Banks, for example. I have always been a bit confused that some investors feel they need to wait until the water is absolutely safe before they go back in. That’s not really a recipe for success when investing. You have to go in when there is an element of risk. I think that investors or asset allocators started to think, after the French election, that political risk in Europe had gone. All of the above created an environment where asset allocators came back to Europe.
Do you think it will continue?
I think Europe has further to run. I think Europe remains a catch-up trade. I would not join the camp of European equities fund managers who say that Europe is going to close the valuation gap completely with the US. But when I look at the valuation of US equities, and I look at the valuation of European equities, one of them is wrong. If US equities are right at current prices, then Europe has a lot further to go.
Will European banks remain a theme?
I think banks are going to continue as a theme, subject to one major proviso – the shape of the yield curve, which is worrying me as a bank investor and as a fund manager whose portfolio is tilted to value. I am very worried about the lack of inflation and the effects that has on bond yields. I think banks have further to go. Stock prices are at 12-month relative highs as we speak and they have done that despite no help from the bond yield curve. They have done it through earnings, through restructuring, through the much-needed building of capital. We have just come off the third consecutive good quarter for bank earnings. We are celebrating that because we had a nuclear winter for bank earnings, and for banks in general, that lasted a decade. We are coming out of that, so I don’t think that the positive mean reversion for bank earnings and bank stock prices is over in only a year.
What is exciting you as a stock picker?
I have over 30% in financials at present, which is largely banks, so I can’t really say that I’m not excited about a bank. I am the first to say ‘European banking – handle with care’, but I think that is in the past. If I were to pick one bank, I would say ABN Amro. Notwithstanding that we are likely to get Dutch government placing in the near future, I think that once that is past, it clears the way for further terrific performance from ABN Amro. I think the strength of the Dutch economy helps a lot. I think management’s focus on building capital is attractive. I think the valuation is attractive. So among the banks I think ABN Amro is really quite attractive in the short term.
Looking at non-banks, if you’re not in the market for instant gratification, I like Nokian Tyres, in Finland. I just met with management and we recently became shareholders. I don’t think it is necessarily going to perform in the rest of 2017. But I look at the return on capital in that business as a tyre manufacturer. Nokian used to make everything from televisions to wellington boots, but this is the tyres business, specialising in winter tyres, with a large part of its output coming from Russia. The company is building a new plant in America. If I look at the expected return on capital for when that plant is fully up and running, probably by 2020, I really like the profile. There is really something for everyone there.
Is Brexit affecting your thinking?
My view on Brexit and how it is affecting my thinking is exactly the same as it was in the lead up to Brexit (the vote). Ignore it. It has no impact whatsoever on my thinking.
Asset allocation/allocators: Asset allocation is a strategy where investors aim to balance risk and reward by allocating parts of their portfolio to different parts of the market, or across asset classes (eg. stocks, bonds, property, cash, in the US, UK, Europe, Japan or emerging markets). Asset allocators adjust their portfolio to reflect changing market conditions and their own objectives.
Earnings trajectory: The direction of earnings for a company or market, either up (indicating that earnings have been increasing) or down (falling).
Placing (placement): A placement is the sale of shares (or bonds) to a selected list of clients, such as companies or governments.
Return on capital (return on equity): The amount of income a company generates for shareholders, expressed as a percentage of the company’s shares in existence. It is a measure of a company’s profitability as it shows how much profit a company generates relative to the money that shareholders have invested.
Stock: A company’s stock is the body of shares, representing ownership, typically listed on a stock exchange.
Value (value investing): Value investors search for companies that they believe are undervalued by the market, and therefore expect their share price to increase over time.
Yield: The level of income that comes from an investment, typically expressed as a percentage rate.
Yield curve: A graph that plots the yields of similar quality bonds (loans) against their maturities. In a normal/upward sloping yield curve, the yields on bonds with a long time to maturity are higher than short-term bond yields. This reflects the greater risk over time that the loan may not be repayed. A yield curve can also signal market expectations about a country’s economic direction.